Ratio Between Defensive, Cyclical Stocks Suggests Market Bottoming

Over the last 18 months U.S. equity markets have seen a rotation into defensive stocks. While this rotation typically coincides with bear markets for equities, it has this time coincided with a rally for the S&P 500. The index is up more than 7 percent since May 31, 2011. Meanwhile, the relationship between cyclical and defensive stocks appears to be bottoming while cyclical sectors are beginning to gain momentum, suggesting the S&P 500 gains may be extended.

Chart 1 shows why the market’s recent behavior runs counter to ‘normal’ market mechanics where cyclical stocks typically outperform in equity bull markets. As the equity market has made new highs since September 2011, cyclical stocks have underperformed.

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